Sin Tax Error?

My AFR op-ed today is on tobacco and alcohol taxes. Full text over the fold. Some references are hyperlinked, and there’s more detail at the end of the piece.


‘High Taxes Not Without Sin’, Australian Financial Review, 30 March 2010

In The Australian Legend, Russell Ward wrote ‘no people on the face of the earth ever absorbed more alcohol per head of population’ than Australians in the 1800s. While scholars debate Ward’s precise claim, it is clear that European settlers consumed vast quantities of alcohol. And 80-90 percent of men smoked.

Substance abuse is inextricably linked to Australian history, where rum and tobacco often took the place of cash. Today, 19 percent of us are regular smokers, while 13 percent of us are risky drinkers (defined as more than 4 drinks a day for men, and more than 2 drinks a day for women). Compared with other developed countries, we have relatively few smokers, and a slightly above-average level of alcohol consumption.

Can sin taxes make us pure? In the case of cigarettes, you might expect that most buyers would be addicts, and therefore unresponsive to prices. But it turns out that smokers are surprisingly price-sensitive. On average, a 10 percent price hike cuts cigarette sales by 5 percent. Although this is offset slightly by an increase in intensity (higher taxes induce smokers to take a few extra puffs out of each cigarette), the health benefits are still substantial. Teens are two to three times as price-responsive as the rest of us.

Put another way, if tax increases were to raise the price of a cigarette from 50 cents to 55 cents, we might expect 150,000 of Australia’s 3 million smokers to kick the habit. The same price rise would probably also deter thousands of high school students from becoming addicted in the first place. Because many smokers want to quit, half of all smokers support higher cigarette taxes – suggesting that such a policy might find favour at the ballot box.

For alcohol, it is less obvious that higher taxes lead to better health outcomes. Unlike smoking, moderate alcohol consumption does not seem to be bad for you (indeed, occasional tipplers may even gain a health benefit). So raising the price of grog is only a good public health measure if it reduces the kind of heavy consumption that is associated with cirrhosis of the liver and misuse (such as drink driving and domestic violence). If higher alcohol taxes deter grandma from having a glass of sherry, but do nothing to prevent the lad on the corner pub from sinking his sixth schooner, we should rate them a public policy failure.

It turns out that alcohol taxes deter both groups. On average, a 10 percent increase in price reduces overall consumption by 5 percent, and lowers heavy drinking by a little less – perhaps around 3 percent. There is also some direct evidence that higher alcohol taxes reduce drink driving, with one US study suggesting that a 10 percent increase in alcohol prices would reduce road fatalities by 6 percent (saving perhaps 90 lives annually). However, because binge drinkers are less price-responsive than the rest of us, alcohol taxes are a blunt instrument for cutting road deaths.

What about the equity implications of sin taxes? In the case of alcohol, drinking rates rise with incomes, so alcohol taxes are modestly progressive.

Cigarette taxes create something of a paradox. Since the poor are more likely to smoke, cigarette taxes are regressive. Yet a rise in cigarette taxes induces more quitters among the low-income population. So for hard-core addicts, cigarette taxes fall more heavily on the poor. But cigarette taxes can be a powerful tool for improving health outcomes among the disadvantaged. Over recent decades, much of the drop in smoking has been due to higher prices, so you don’t have to be a wowser to see the potential for increased taxes to produce better health outcomes.

Will this election give Australian headline writers the chance to bring out those old front pages that said ‘Beer, cigs up’? In conjunction with restrictions on sales and advertising, sin taxes have proved an effective public health policy. Alas, they also have unintended consequences – reducing moderate alcohol consumption, and acting as a regressive tax on low-income smokers who are never going to quit. Even virtuous taxes have their vices.

Andrew Leigh is a professor in the Research School of Economics at the Australian National University. He is presently a candidate in the ALP preselection for the federal seat of Fraser.

In case you’re wondering about whether a 10% rise in alcohol prices is a good way to save 90 lives, here’s my thinking. According to my research assistant Jenny Chesters and the 2003-04 Household Expenditure Survey, Australia spends $9.3 billion per year on alcohol (7.7 million households x $1200), so a 10% price rise is $930 million. Assuming reasonable deadweight costs, it’s likely that the social cost of this exceeds the cost of saving 90 lives (which standard benchmarks would put around $315 million). In other words, for the same societal resources, we could save more lives in other ways.

Of course, the optimal alcohol tax rate would be low on the first drink, and rising steadily thereafter. Fame and riches to anyone who can work out how to implement this in practice.

Other useful sources include this Cato debate. Harry Clarke also has extensive writings on tobacco and alcohol, which I probably should have referenced in the AFR.

In case anyone is interested in the politics of it all, the only publicly available survey I could find that asked about voting and smoking was the 1990 Australian Election Study. On primary votes, never-smokers split 39% ALP/48% Coalition, ex-smokers broke 41% ALP/48% Coalition, and chain smokers (>20/day) voted 52% ALP/35% Coalition.

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2 Responses to Sin Tax Error?

  1. Harry says:

    Andrew, thanks for a very interesting article. i’ve always been curious about price elasticities on tobacco taxes but never had the initiative to follow it up. i was particularly interested in the data on the price sensitivity of teen smokers, and the poll results for smokers vis a vis higher tobacco taxes.

    i’d be interested to know if there’s any data on the impact of higher alcohol taxes on domestic violence. my guess is that the link between heavy drinking and violence would be fairly strong, so even a mild reduction in heavy drinking could have some fairly significant benefits on this front (although i dunno whether that’s enough to pass the C/B analysis).

    one minor quibble. you say: “Put another way, if tax increases were to raise the price of a cigarette from 50 cents to 55 cents, we might expect 150,000 of Australia’s 3 million smokers to kick the habit”. Isn’t an alternative construction that we might expect 300,000 smokers to halve their annual consumption? Perhaps some will be nudged along to kick the habit entirely but it seems to me that that’s a much stronger claim.

  2. Rob says:

    Andrew – a couple of points

    Using the HES for analysis of expenditure on ‘sin’ products is always a little bit dodgy because people are not very good at reporting their spending on these products – either because they do not wish to be seen in engaging in sinful activities, or because receipts are often not collected by them. (While people are likely to keep their receipts from the supermarket and put them into their expenditure diary, they are less likely to have a set of receipts from a night at the pub, or for a packet of smokes.)

    A Treasury paper from some years ago (Carnahan, M. 1998, Does Demand Create Poor Quality Supply: A Critique of Alternative Distributional Analysis), reports that the weighting given to alcohol in the CPI exceeds its share of HES expenditures by 91 per cent, while for tobacco the proportion is 59 per cent. For analysis the problem is whether this under-reporting is distributed in the same way as the actual reported spending.

    On alcohol consuption the relationship between income and spending is confused by the variation in quality – and when it comes to tax effects from the differential taxation of various products (high taxes (relative to alcohol content) on spirits and expensive wines, low effective taxes on wines from small producers, etc) something the Henry Inquiry has documented in its various publications.

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